State Capitalism by Stealth, the New 21st Century Economic Reality

Op-ed on the beyondbrics forum of the Financial Times

April 16, 2015

Geoeconomics was defined by its intellectual godfather, Edward Luttwak, as a contest defined by the grammar of commerce but the logic of war. Today, one of the most pernicious tools in this global contest is the evolving role of government in a market economy. It was one thing to fight the battle of communism versus capitalism. It is quite another to fail to recognize today's competition is increasingly over the rules, norms, and tools of state involvement in capitalism itself.

For decades, the US-led global economic order largely advocated the position that the economic role of government should be limited. Ideally, governments should set the ground rules for investment and commerce via just laws and regulations and enforce them fairly both domestically and internationally. Beyond that, let the free market rule.

Twenty-first century geoeconomic reality may well be characterized by a model of market capitalism in which the state plays a central and ongoing role in directing outcomes to advance national interests.

In the messy aftermath of the financial crisis, however, governments and central banks stepped into roles that contravened the pursuit of this limited government approach, hoovering up stakes in banks, companies, and market-issued securities to fill vacuums created by precrisis excesses and post-crisis political failures. Now, with the worst of the crisis seemingly behind us, many investors and businesses yearn for a return to "normalcy," allowing them to once again focus on market-based "signals" without the distortions of state-directed "noise."

They may be disappointed. Twenty-first century geoeconomic reality may well be characterized by a model of market capitalism in which the state plays a central and ongoing role in directing outcomes to advance national interests. Until recently, the term "state capitalism" referred primarily to state-owned enterprises competing with private companies on an unlevel playing field. Think Gazprom. Or opaque sovereign wealth funds buying interests in foreign banks and ports, with (largely unfounded) suspicions that their motives were political.

More recently though, state capitalism has evolved and now includes more sophisticated and subtle means of state involvement. Let's call it State Capitalism 2.0, where governments intervene in markets through subtler tools.

For companies seeking to compete across borders, this does not bode well. State involvement means less certainty, less security, and less recourse to legal means to make things right. It means a greater need to assess the strategic priorities of countries in which businesses seek to operate overseas. One government's protected strategic sector could easily be another's welcomed investment opportunity.

Telecommunications might well be considered strategic and protected in one country that openly courts renewable and alternative energy, while another country might dictate that its energy sector is worthy of state privileged protection while actively seeking outside investment to build up a viable smart grid and telecommunications infrastructure.

Today's state capitalism can include the use of ostensibly benign legislative, regulatory, and other policy tools, including "anti-monopoly" authority, which are used to protect and strengthen state-owned enterprises and national champions under the guise of promoting competitive markets. "Leveling the playing field'" is increasingly used against international competition so as to promote strategically important economic outcomes. All in the name of the rule of law.

Western companies have long argued that Chinese antimonopoly regulation has unfairly targeted their operations, ostensibly to protect the integrity of a competitive market. Last summer, the Beijing-based European Chamber of Commerce criticized the government's crackdown on alleged violations of the country's 2008 antimonopoly law, complaining that they had been subject to "intimidation tactics" by officials.

Foreign car manufacturers—from Audi and Mercedes-Benz to Chrysler—have all been subjected to Chinese antitrust investigations. US chipmaker Qualcomm paid a $975m fine to Chinese authorities to settle alleged antimonopoly violations. All have raised concerns from those who recognize China's growing clout in the global marketplace and its increasing willingness to use that clout to skew market outcomes to its liking. China is far from alone in this regard.

As the composition of the global economy evolves, agreement on cross-border standards and regulatory frameworks become increasingly important in establishing new rules for operating in strategic sectors, in particular in finance, energy, the media, and technology. Those standards are being set (or impeded) by countries whose national champions dominate or seek to challenge incumbents in strategic industries and sectors.

The strong push by the United States to complete the Trans-Pacific Partnership (TPP) trade agreement is, at its core, an effort by the United States and like-minded others to ensure that rules and standards governing trade and investment covering over 40 percent of the world's GDP remain open, transparent, and based on an operating environment governed by fair application of the rule of law.

Similar efforts are underway between the United States and Europe in connection with the Transatlantic Trade and Investment Partnership (TTIP), where tough negotiations risk exposing the rift between the US and EU visions of the appropriate role of the state in the economy, how to foster health competition, and the protection of national champions.

Existing national champions and dominant market actors working closely with their national governments could see their positions solidified or enhanced as they work to promote favorable internationally agreed upon standards and outcomes skewed to protect their interests. Conversely, companies with dominant market positions, achieved under existing rules and norms but without explicit home country government support, will find themselves vulnerable.

US technology companies, for example, could face a perilous future as their dominant market positions could be threatened if new operating standards are formulated while the US government declines to explicitly promote its own national champions.

Perhaps the biggest losers in this new era of state capitalism might be international institutions whose mandates were crafted with the objective of seeking to promote the so called "Washington Consensus." These institutions are now at risk of being sidelined by this new model where countries support their own national interests by putting government-favored business and strategic interests ahead of long-held, though perhaps outdated, principles.